5 Henderson Structured Settlements FOREWORD A good deal of literature has been produced about structured settlements since their inception here in Canada circa Most of this originates with structured settlement firms, and most amounts to little more than advertisement. Essentially, all of this literature makes the same point: structured settlements are, in many circumstances, preferable to lump-sum settlements. While explanations and illustrations are offered in support of this, most of us are, unfortunately, probably still no better able to make informed decisions about structured settlements now than we were prior to being exposed to this literature. The foregoing, then, points out a deficiency not in structured settlements -- the virtues of which are indisputable -- but rather the manner in which the story is told. Clearly, there is a need for literature that is written from the perspective and in the language of the consumer. This guide is intended to serve this need. The terms of reference stipulated that it be both objective in the information presented and useful to those claims personnel and lawyers who would have a real interest in reading it. Consequently, the success of the material that follows should be judged principally in reference to these terms. 3

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7 Henderson Structured Settlements INTRODUCTION In keeping with the remarks made in the foreword, information of a historical or highly technical nature will be kept to a minimum. For example, while the complete history of structured settlements may be of academic interest, a knowledge of this does not really assist in the process of deciding whether a given situation is amenable to settlement by structure or not. Likewise, it is not essential that the user be intimately familiar with the mathematics of annuities. In other words, the tack taken here will be, to the greatest extent possible, practical, rather than theoretical. The manual itself has been organized on the basis of a series of fundamental questions. These are: 1. What are structured settlements? 2. Why use structured settlements? 3. Which cases can be structured? 4. When should a structured settlement consultant be contacted, and what can a structured settlement consultant do? 5. How do you negotiate using structured settlements? Each of these questions translates into chapters. In addition to these, Canada Revenue Agency s Interpretation Bulletin IT-365R2, the bulletin pursuant to which structured settlement income is deemed tax-free, has been appended. 5

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9 Henderson Structured Settlements CHAPTER 1 - WHAT ARE STRUCTURED SETTLEMENTS? Definition The term structured settlement has been defined in a variety of ways. The judicial definition offered by the Supreme Court of Ontario in Yepremian v. Scarborough General Hospital (No. 2) is perhaps the simplest and easiest to understand: Structured settlements are a means whereby all or part of the damages are paid to a claimant by means of periodic payments rather than by means of a lump sum. 1 Structured settlements, then, represent an alternative to the conventional lump-sum settlement; that is, they replace the traditional single payment with, primarily, a series of periodic payments. This is not to say, however, that structured settlements do not allow for lump-sum payments. The term structure comes from the idea that a settlement can be shaped to meet the needs of the situation. As we shall see, structured settlements can be formulated to allow up-front lump-sum payments, to allow income to be varied from year to year, to allow certain elements of income to be deferred, to allow for lump-sum payments at various times in the future, and to allow for the escalation of payments (i.e., indexation) in an effort to offset the effects of inflation. History 2 Structured settlements were first employed in Sweden, France, West Germany, Australia, and New Zealand in the early 1950s. They first appeared in the United States in 1958 in the form of a structured judgment. Since then, structures have been used extensively on a voluntary basis in the United States, and some states have gone so far as to enact legislation to allow the courts to impose structured judgments. Some of the more notable American cases in which structured settlements have been employed are the thalidomide cases of the 1960s and the Ford Pinto cases of the 1970s. In fact, structured settlements were introduced to Canada in 1968 by virtue of the American thalidomide cases. They did not, however, gain widespread popularity in this country until the 1980s, when the tax-free status of structures was finally confirmed by Revenue Canada (now Canada Revenue Agency). This, combined with an influx in the number of million dollar awards during this period, served to make structured settlements an attractive alternative to the lump sum. 3 In fact, 7

10 The User s Guide to Structured Settlements some Canadian jurisdictions have enacted legislation that allows the courts to impose structured judgments in certain circumstances. 4 Anatomy of a Structured Settlement As defined above, structured settlements are a means whereby all or a part of the damages paid to a claimant are by way of periodic payments. In particular, structured settlements are usually composed of two distinct elements: a cash portion paid up-front and an annuity payment plan. The former is intended to pay for out-of-pocket expenses and wage loss incurred prior to settlement, as well as any necessary capital expenditures, such as home and vehicle modification, legal fees, and the like, whereas the latter is designed specifically to provide a stream of payments (usually monthly) to meet the claimant s future financial needs. Henderson Structured Settlements An annuity is defined generally as a contract... for the payment of periodic amounts during the lifetime of a particular person, or for a fixed or guaranteed period... 5 More specifically, an annuity policy is a contract between an issuer and an owner, whereby the issuer, in return for a premium, agrees to pay a specific amount of money on a regular periodic basis at fixed intervals, to begin on a designated date and continue for life or such shorter or longer period as agreed by the owner and issuer. 6 Any annuity payment plan used in the context of a structured settlement will consist of a combination of features of each of the following categories: 7 1. Payment of the purchase price: (a) Single Premium: One-premium policy whereby no further premiums are due or payable beyond the large single payment at the beginning of the contract. 2. Benefit distribution period: (a) (Straight) life: Benefit payments continue as long as the measuring life lives; that is, they cease upon death. There is no guarantee that any particular number of periodic payments will be made, and benefits could cease (because of the death of the measuring life) after as little as one payment being made by the life insurer. 8 This form of annuity is generally not popular for use in structured settlements, notwithstanding that it produces the largest individual periodic payment. 8

11 What Are They? Henderson Structured Settlements (i) Joint and last survivor: Policy provides that payments will be made to more than one individual, but will cease at the death of the last surviving measuring life. (ii) Standard: No anticipated deviation from the life expectancy set out in the tables. 9 (iii) Non-Standard (impaired, rated-up): Anticipated deviation from the life expectancy set out in the tables in the form of the early death of the particular measuring life, derived from an assessment of his or her current and projected state of health. A non-standard assessment generally results in a substantial premium savings and/or benefit enhancement compared to a standard-rated individual because of the anticipated shorter payout period. (b) Guaranteed term certain: Fixed number of periodic benefit payments are made to the injured claimant, and his or her beneficiary or estate as the case may be, without reference to the life or death of any individual. The premium cost for any particular benefit level will vary directly with the length of the guarantee to beneficiary period. (c) Life plus minimum guaranteed term certain: Most common form of structured settlement annuity, by which benefit payments cease at either the death of the measuring life or the conclusion of the guarantee to beneficiary period, whichever comes last. The optimum guaranteed period depends upon the settlement funds available, the immediate needs of the claimant, and his or her life expectancy. 3. Commencement of benefit payments: (a) Immediate: Payments begin immediately upon payment of the full premium. (b) Deferred: Commencement of the benefit payments is delayed. On a deferred basis, benefits do not start until a specified time in the future, notwithstanding that the entire premium has already been paid in full. For example, payments may be deferred for five, ten, or fifteen years, or until the measuring life attains the age of majority or until retirement. 9

12 The User s Guide to Structured Settlements 4. Nature of the payments: (a) Fixed level payments: Providing one specified dollar amount, which does not increase or decrease throughout the entire payment period, under any circumstance. (b) Variable payments: Such payments are employed in an effort to protect the purchasing power and value of the benefits from inflation during the payout period. This feature is frequently used in structured settlement annuities. The amount of variation can be determined in a number of ways. The most common are: (i) Indexed-Variable: Automatic cumulative cost-of-living adjustments in accordance with changes in a specified index; for example, the Consumer Price Index (CPI). Henderson Structured Settlements (ii) Indexed-Fixed: Payments are automatically increased each year on a cumulative basis by a specified percentage or dollar amount. This is the most common form of variation in the structured settlement context. (c) Combination periodic (fixed or variable) payments and lump sum(s): Annuity payments are, by definition, strictly periodic in nature. An annuity policy may, however, include one or more lump-sum payments to be made on an ascertained or ascertainable future date. This is, again, a very common form of structured settlement annuity policy. 5. Miscellaneous provisions: (a) Custom provisions: Some of the custom provisions utilized with structured settlements include: beneficiary designation; non-assignable (neither the policy nor any proceeds therefrom are capable of being assigned by the owner or the annuitant, collaterally or otherwise); non-commutable (a provision that prevents the owner, annuitant, or, most importantly, any of their creditors from collapsing the policy for its present-value lump-sum equivalent); non-transferable (neither the policy nor any proceeds therefrom are capable of being transferred by the owner or the annuitant, collaterally or otherwise). (b) Boilerplate: Fine print provisions inserted to provide protection for both the annuity issuer and the owner or annuitant. 10

13 What Are They? Henderson Structured Settlements The foregoing, then, constitutes the menu of options from which the annuity portion of a structured settlement is formulated. To illustrate, a relatively uncomplicated structured settlement might begin with an up-front lump-sum payment (to pay past lost income and legal fees, for example) and be followed by an annuity policy featuring (in the order of the foregoing categories): 1. a single premium; 2. a standard life plan with a minimum guaranteed (to a beneficiary) term certain; 3. an immediate start time; 4. a combination of periodic (variable, indexed-fixed) and lump-sum payments; and 5. the non-assignable, non-commutable, and non-transferable provisions. Of course, the size and timing of both periodic and lump-sum payments, the guaranteed period, and the rate of inflation protection are all variables that would be determined ultimately by the size of the loss or premium available and the financial needs and expectations of the claimant. Notes to Chapter 1: 1. (1981), 31 O.R. (2d) 384 (Ont. H.C.) at For a more complete history of structured settlements, see Leanne Todd, Structured Settlements and Structured Judgments: Do They Work and Do We Want Them? Dalhousie Law Journal 12 (November 1989): The increase in million dollar awards was to a significant degree attributable to the principles of damage assessment established in The Trilogy cases handed down by the Supreme Court of Canada in In particular, see Andrews v. Grand & Toy Alberta Ltd., 2 S.C.R. 229 (S.C.C. 1978); Thornton v. School District No. 57 (Prince George), 2 S.C.R. 267 (S.C.C. 1978); Arnold v. Teno, 2 S.C.R. 287 (S.C.C. 1978). 11

14 The User s Guide to Structured Settlements 4. For example, see Courts of Justice Act, R.S.O. 1990, c.c.43, ss. 116 and 116.1, Insurance (Vehicle) Act, R.S.B.C. 1996, c. 231, s. 99, and Judicature Act, R.S.A. 2000, c.j-2, s D. Norwood, The Uniform Life Insurance Law of Canada (Toronto: Life Insurance Institute of Canada, 1974), 18, quoted in John P. Weir, Structured Settlements (Toronto: Carswell Legal Publications, 1984), Ibid., This material was synthesized primarily from the table and text presented by Weir, ibid., Please note that all structured settlement payments are guaranteed to the measuring life or recipient for the term of the plan (e.g., life in this case). In addition, a structured settlement might be guaranteed to a beneficiary for a period of time. If the recipient were to die within this guaranteed period, the beneficiary would then receive the payments, tax free, for the balance of the guaranteed period. Henderson Structured Settlements 9. The tables referred to here are the life expectancy tables published by Statistics Canada. 12

15 Henderson Structured Settlements CHAPTER 2 - WHY USE STRUCTURED SETTLEMENTS? The most obvious motivation for settling injury claims, in whole or in part, by means of a structured settlement is found in the income tax treatment of lump-sum damages received in personal injury or fatal accident cases in Canada. In general, compensatory damages for personal injury are not subject to tax. However, the income derived from the investment of these damages is. Only income generated by way of investment in a structured settlement is, in effect, tax free. In order to invest in and derive the tax benefits of a structured settlement, the following conditions must be met: 1 1. The damages to be invested must be in reference to a claim for personal injury or death. 2. The claimant and the casualty insurer must agree to settle by way of a structure The casualty insurer must purchase a single premium annuity policy to produce the periodic payments stipulated in the settlement agreement. 4. The casualty insurer must be both the owner and annuitant (beneficiary) of the annuity policy. 5. The annuity policy must be non-assignable, non-commutable, and non-transferable. 6. The casualty insurer must irrevocably direct that the payments be made to the claimant. 7. The casualty insurer must remain liable to make the periodic payments required by the settlement agreement in the event the life insurer defaults. While the casualty insurer, as owner and annuitant/beneficiary of the annuity policy, is taxed on the income generated for the claimant, this tax exposure ultimately amounts to nothing, because the settlement is treated as a deductible expense. Moreover, while it was once necessary to obtain an advance ruling from Canada Revenue Agency (CRA) to ensure the tax-free status of any given structured settlement, this is generally no longer required. 3 Structured settlements, then, can, because of the foregoing tax arrangement, produce more income for less investment cost. Consequently, both the claimant and the casualty insurer win. The only 13

16 The User s Guide to Structured Settlements potential loser, given the tax revenue foregone, is CRA. However, this loss is mitigated by the elimination of the potential for lump-sum dissipation and the burden of support this invariably imposes on government. 4 Structured settlements offer advantages beyond the basic tax-induced advantages of a higher rate of income return for claimants and lower loss payments for casualty insurers. In particular, structured settlements offer claimants the equally important additional advantages of: 1. security in the form of regular, guaranteed payments, received in the same periodic way that income and expenses are generally received; 2. flexibility (at least at inception) in that a structured settlement can be, by reference to the menu of annuity options, tailored to the anticipated needs of the claimant; Henderson Structured Settlements 3. the elimination of the risk of dissipation and thereby the risk of becoming dependent on government assistance; and 4. financial management without a fee. Similarly, structured settlements offer casualty insurers the additional advantages of: 1. earlier settlements and therefore savings realized in terms of reduced legal costs and prejudgment interest, because of the attractiveness of structured settlements; and 2. elimination of bad faith potential by facilitating settlement within policy liability limits. Nonetheless, there is a down side to structured settlements. For the claimant, the principal disadvantage is, ironically, the inflexibility of structured settlements. Once in place, a structure cannot be altered in response to a change in the claimant s needs. 5 For the casualty insurer, there are essentially two disadvantages to structured settlements. First, there are administrative costs associated with the tax that the annuity portion of the structure attracts and the attendant need to retain a claim file (albeit a retired claim file). Second, there is a contingent liability that the casualty insurer assumes when it guarantees the payments made from the life insurer to the claimant. 6 14

17 Why Use Them? Henderson Structured Settlements Notes to Chapter 2: 1. The tax treatment of structured settlements is set out in Interpretation Bulletin IT-365R2, issued by Revenue Canada (now Canada Revenue Agency) on May 8, Please see the appendix. 2. While structured settlements usually involve casualty insurers, Canada Revenue Agency does permit others (e.g., self-insurers) to settle damage claims by structured settlement, subject to the same conditions. However, it should be noted that a structured settlement cannot be obtained without the consent of the insurer, casualty or otherwise; that is, a structure cannot be purchased unilaterally by the claimant. 3. Some still insist upon advance rulings as a matter of procedure. However, notwithstanding cases involving more unique fact situations (e.g., extraterritorial cases), these are generally not necessary. 4. CRA s loss is further mitigated by the tax revenue that structured settlement companies generate through their operations. 5. This inflexibility is, of course, also a virtue; that is, the inflexibility of a structured settlement eliminates the potential for lump-sum dissipation. 6. The potential insolvency of a life insurer would appear to be a disadvantage in theory only; that is, no life insurer in Canada has ever failed to meet its financial obligations. Nonetheless, if on-going administration and contingent liability were a concern to a casualty insurer, the ownership of a structured settlement could be assigned. 15

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19 Henderson Structured Settlements CHAPTER 3 - WHICH CASES CAN BE STRUCTURED? Structured settlements represent an alternative to, rather than a replacement for, lump-sum settlements; that is, they are not appropriate in all cases. For example, a structured settlement may not be appropriate in the case of a claimant who would like to purchase a business, particularly if the business is within the claimant s ability and would assist in his or her rehabilitation to a productive life. Nonetheless, there are a wide variety of circumstances in which structures are a most appropriate means of settlement. These circumstances can be categorized by reference to the nature of both the claim and the claimant: 1 Claim Types Amenable to Structured Settlements 1. Excess of $50,000 Although structured settlements can be devised on the basis of any principal, $50,000 is generally considered the point at which the additional administrative cost of designing and negotiating a structured settlement is justified by the tax and loss payment savings produced. Infants and claimants in high tax brackets, however, are clear exceptions to this rule. In the case of infants, given that payments are deferred often ten to fifteen years, the investment of even a small amount in a structured settlement can result in substantial payments eventually being generated. Similarly, in the case of claimants who are either in a high tax bracket to begin with or would be pushed into a higher tax bracket by the interest from a lump sum, the investment of, again, even a small amount in a structured settlement can produce significant tax savings. 2. Serious Bodily Injury The more serious the injury, the greater the damages and therefore the greater the tax and loss payment savings structured settlements have to offer. Moreover, the more serious the injury, the greater the future care costs and, as will be explained below, the greater, again, the benefits structures have to offer. 17

20 The User s Guide to Structured Settlements 3. Fatal Injury and Dependency Fatal injury or wrongful death claims in tort are intended to compensate the surviving dependants for their future loss of support. This type of loss is assessed on the basis of after-tax dollars in most Canadian jurisdictions and subsequently grossed-up for the tax that investment of this amount would attract. A structured settlement allows the casualty insurer to avoid the expense of gross-up and return some of these savings to the claimant(s) by way of enriched benefits. Moreover, regardless of gross-up, structured settlements still offer, as explained above, tax and loss payment savings in proportion to the size of the loss. 4. Future Care Henderson Structured Settlements Like fatal injury claims, future care claims in tort are assessed on the basis of after-tax dollars in most Canadian jurisdictions and subsequently grossed-up for taxes. Consequently, for the reasons cited above, this type of claim is also amenable to a structured settlement Future Lost Income Future lost income claims in tort are assessed on a pre-tax basis in most Canadian jurisdictions and therefore there are no gross-up savings associated with the use of structured settlements. Nonetheless, a structure can still produce tax and loss payment savings for claimants and casualty insurers, respectively, in proportion to the size of the loss. 6. Excess Limits Lump-sum damages often exceed the liability limits of the casualty policy in question. This can result in the personal assets of the liable insured being placed at risk, the claimant being confronted with the expense of collecting against the personal assets of the liable insured, and, ultimately, a bad faith suit being launched by the liable insured against the casualty insurer. 3 These cases can, however, often be resolved within the liability limits by taking advantage of the tax and loss payment savings that structured settlements offer. 18

21 Which Cases Are Appropriate? Henderson Structured Settlements 7. Multiple Parties As in the case of excess limits claims, structured settlements can be used to resolve claims in which there are multiple claimants and/or casualty insurers and limited compensatory funds. 8. Questionable Liability or Quantum Structured settlements offer a compromise solution to claims in which liability or quantum is inconclusive and the potential loss payment is significant. Again, by virtue of the tax and loss payment savings offered by structured settlements, the risk of an all or nothing outcome can be avoided and replaced by an outcome acceptable to both claimant and casualty insurer. 9. Punitive Damages The tax and loss payment savings realized through structured settlements provide an effective means of minimizing both the size and attendant adverse publicity of punitive or exemplary damage claims. 10. First Party Claims (Accident Benefits) Because first party Accident Benefits payments are made directly by the casualty insurer on a tax-free, periodic basis to begin with, there is no tax advantage to structured settlements in this context. Nonetheless, the fact that Accident Benefits and structured settlements both produce tax-free income makes structured settlements a most appropriate means of evaluating and settling Accident Benefits claims. Claimant Types Amenable to Structured Settlements 1. Infants Structured settlements are almost invariably appropriate in the case of infants. As explained above, virtually no principal amount is too small for investment in a structure if the claimant is relatively young. The rate of return on investment in a structured settlement usually exceeds the interest earned on a lump sum paid into court or held in trust. Moreover, although investment income from a 19

22 The User s Guide to Structured Settlements lump sum is usually tax exempt until an infant reaches the age of twenty-one, a structure can extend the tax exemption period beyond twenty-one and thereby produce the tax and loss payment savings cited above. Finally, a structured settlement, because of its periodic nature, can provide protection against premature dissipation, which is invariably a large risk, particularly at age of majority. 2. Financially Unsophisticated Most injured claimants have neither the ability nor the desire to manage an investment portfolio of significance. Structured settlements are guaranteed and self-managing and therefore preclude the risk of premature dissipation and the need and expense associated with financial management Reduced Life Expectancy Henderson Structured Settlements Structured settlements almost invariably provide higher rates of return than conventional investments for claimants who, by virtue of their injury or life conditions, have a shorter than normal life expectancy. 4. Compensation Neurosis Structured settlements, because they tend to produce earlier settlements in a less adversarial fashion, may be of therapeutic value in the context of claimants suffering from, or likely to suffer from, compensation neurosis. 5. Marginal Rate of Income Taxation As explained above, claimants who are either in a high income tax bracket to begin with, or would be pushed into a higher income tax bracket by the interest earned on the investment of a lump sum, would derive a larger benefit from tax-free structure income. 20

23 Which Cases Are Appropriate? Henderson Structured Settlements Notes to Chapter 3: 1. Weir, Structured Settlements, In Ontario, pursuant to section of the Courts of Justice Act, structured settlements are mandatory in reference to damages for future care in excess of $250, arising out of a medical malpractice action. 3. In this regard, see Pelky v. Hudson Bay Insurance Co., I.L.R. 720 (Ont. H.C. 1982). 4. According to an oft-cited American study (see Weir, Structured Settlements, 18), the dissipation rate among settlement recipients is such that 25% of them have nothing left within two months, 50% have nothing left by the end of the first year, 70% have nothing left within two years, and 90% have nothing left within five years. 21

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25 Henderson Structured Settlements CHAPTER 4 - WHEN SHOULD A STRUCTURED SETTLEMENT CONSULTANT BE CONTACTED, AND WHAT CAN A STRUCTURED SETTLEMENT CONSULTANT DO? A structured settlement consultant might be called upon at any time during the claim settlement process. In the past the convention was to call a structured settlement consultant when a claim was settled and some or all of the damages were to be structured. Increasingly, the practice has evolved so that contact is earlier. Structured settlement consultants are now often employed, to good advantage, for pre-settlement evaluative purposes; that is, to evaluate, via structured settlement costs, the present value of various future damage scenarios and provide structured settlement illustrations in reference to various potential settlement amounts (thereby demonstrating how and whether these amounts invested in a structured settlement might underwrite the claimant s future needs). The structured settlement consultant s role is non-partisan. The assumptions underlying the assessment of damages and the negotiation over these assumptions is something left to the parties involved in negotiation. The structured settlement consultant s role is simply to assist in both the assessment and investment of these damages. The services provided by the structured settlement consultant can be categorized generally in terms of education and consultancy (both pre- and post-settlement). The educational services provided by the structured settlement consultant might include publications, seminars, and meetings intended to encourage familiarity with the concept of structured settlements. In the area of consultancy, the structured settlement consultant s services would include the review and analysis of all material relevant to evaluating damages and designing structured settlement proposals (e.g., medical and rehabilitation reports, future lost income analyses, future care cost analyses, etc.), the production of evaluative reports and structured settlement proposals, attendance at a variety of meetings (e.g., mediations, settlement meetings, pre-trials/trials, individual meetings with claimants and their representatives, etc.), the provision of income tax information, opinions and rulings from CRA, if and when necessary, and assistance in the execution of closing documentation. The qualifications required of a structured settlement consultant exceed mere knowledge of and licensing in the life insurance business and contracts with all the producing life insurance companies. In particular, any shopping list of qualifications should include: 23

McKellar Structured Settlements Inc. STRUCTURED SETTLEMENTS 101 WHAT IS A STRUCTURED SETTLEMENT? The structured settlement is a financial package, designed to meet a particular plaintiff s needs. It does

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